You Bought a MLP for Deferred Taxes, but Now…

You may have heard this past Sunday, it may have been Monday morning, or you’re just reading it now: Kinder Morgan Energy Partners, L.P. (NYSE: KMP) broke news on Sunday August 10 on the consolidation of all the Kinder Morgan entities, which resulted in a 17% increase in the stock value that day. What you didn’t hear is that you’re going to owe Uncle Sam more tax dollars on that sale than on your ordinary stock sale and have less cash from the consolidation to pay the tax. All those tax free distributions you received over the holding period — guess what, your deferral is over! It’s time to pay up for your free cash flow from Kinder Morgan.

Let’s take a step back. What is a Master Limited Partnership and why is there all this talk of deferring taxes? Master Limited Partnerships (MLP) trade like stocks, looks like stocks, but isn’t even close. Simply put, an MLP is a partnership that is listed on a public exchange. Yet, an MLP offers special tax benefits of a limited partnership with the liquidity of stocks. MLPs pay out quarterly distributions to their unit holders and at the end of the year issue a K-1 to each unit holder. So why isn’t that quarterly distribution taxed? MLPs borrow large amounts of money to build things (mostly oil and gas infrastructure or real estate) that offer them depreciation. The depreciation shields the income the partnership produces but still leaves it with a large amount of cash that can be distributed to its unit holders. These tax-free distributions are just a reduction of capital and the K-1 you receive at the end of the year usually shows no income. Voila — tax-free cash!! So how does the consolidation of Kinder Morgan Energy Partners, L.P. affect your tax bill? First, you’re going to get some cash and stock from the deal, currently estimated at $10.77 per partnership unit. Yet according to an estimate by Kinder Morgan, the average investor will end up paying between $12.39 to $18.16 per partnership unit without regard to their own specific circumstances and tax rates. If you would like to know more about MLPs or how it may impact your unique tax situation, please contact your tax professional for assistant with tax planning.